Do Reits have unintended commercial consequences for SMEs?

I invest in Reits for the yields and the brokers and local media have discovered Reits as a great defensive play. But SMEs claim that Reits have caused their rentals to escalate unreasonably. JTC has been asked to review its current policy of divesting industrial space to private entities (like its Ascendas).

Business Times – 02 Feb 2012

SMEs blame Reits for growing rental pains

JTC asked to review its current policy of divesting industrial space to private entities

By MINDY TAN

(SINGAPORE) Rising rentals for commercial and industrial space have emerged as a pressing issue for small and medium enterprises (SMEs), and the fingers are pointed squarely at the dominance of real estate investment trusts or Reits as landlords.

The Reits’ drive to enhance yields and returns for unit holders – which usually translates into rental hikes – have left many SME owners, who feel they have limited alternatives here, fuming.

It has also led to calls – including a recommendation by the newly formed SME Committee – for JTC Corp to review its current policy of divesting industrial space to private entities like Reits and return to its previous role of an industrial landlord, so that it can provide ready and affordable industrial space to SMEs.

‘Rentals and capital values of properties are going up, impacting business costs for SME owners and eating into their bottomline,’ said Lawrence Leow, chairman of the SME Committee.

According to Abdul Rohim Sarip, president of the Singapore Malay Chamber of Commerce & Industry (SMCCI), rental forms between 40 per cent and 50 per cent of operational costs for small businesses. So the increase in rental costs has had a significant impact on their bottom-line.

‘About 40 per cent of these companies (from the retail and manufacturing industries) who seek advisory assistance from EDC@SMCCI have difficulty in sustaining their operational costs and are in need of short-term loans from banks, which is another challenge,’ he added.

Noted Low Cheong Kee, managing-director of Home-Fix DIY: ‘Reits are commercial entities. They will do what they can to keep upping the rent at every renewal whereas JTC had a national agenda to stabilise rent.’

JTC, a statutory board, oversees the development of industrial infrastructure in Singapore. There is clearly frustration among SME owners. An SME owner who did not wish to be named told BT she is currently in negotiations with her landlord, a Reit trust manager, to renew her lease for an additional three years. The new lease agreement is for $28,000 per month, plus 3 per cent of the store’s monthly gross turnover (GTO). She currently pays $17,000 for her 1,000 sq ft unit.

Another SME owner said his rent for a 50,000 sq ft business space in Tuas increased by 56 per cent from $50,000 to $78,000 when he tried to negotiate to renew his lease for eight months.

According to official statistics, rental rates of multiple-user factory space increased 16.2 per cent year on year in 2011, while rental at multiple user warehouse rose 13.3 per cent.

Retail rents also rose on Singapore’s success as a world-class shopping and event destination, but are expected to stabilise in 2012 due to a more muted economic outlook and oncoming supply. Average rents at prime Orchard Road malls went up 4.6 per cent year on year last quarter, while those at prime suburban malls edged up 2.2 per cent, according to CBRE Research.

What rankles too is the perception SMEs have that the odds are stacked in favour of the landlords.

Retailers argue that the practice of requiring tenants to reveal their GTO figures gives landlords an unfair advantage when negotiating rents. Said an SME owner: ‘The current retail market is unbalanced in favour of landlords . . . (since) in the prime retail spaces, you will find that 80 per cent to 90 per cent of landlords insist that their tenants reveal their monthly sales numbers.’

There is also the problem of landlords working in a clause that allows them to terminate tenancy agreements. ‘So even though the lease may be signed for two to three years, and there’s no breach of contract, landlords still have the right to terminate the tenancy of the tenant simply because the landlord feels that another tenant might be able to bring in a better image, sales, or rental . . . So your future is never secure,’ he said.

Greenpac’s chief executive Susan Chong not only had the plus-two-years clause of her lease terminated following the sale of her factory building to a Reit, but is also unable to negotiate a renewal on her existing lease with the new owner. According to Ms Chong, she has been trying to arrange for a lease renewal since October last year. Her lease expires in April.

Her frustration is palpable, given that she only requires the space for an additional eight months. ‘I’m currently building my own factory so I’m asking that they either allow me to rent for an additional eight months, or a year,’ she said. While she will only require the facilities for the next eight months, she is willing to renew the lease for a whole year, she emphasised. But thus far, the landlord’s response to requests to negotiate has been a firm no, citing potential tenants who are looking to lease the property for a minimum three-year term.

Reit managers are quick to point out that rents are a function of market forces, and that they are simply looking to achieve market rates. They say tenants have a choice as to where to locate their business and it would be impossible for Reits to charge rental rates above what the market can bear and what other landlords are charging.

‘Industrial Reits collectively own about 15.8 per cent (about six million sqm) of the total stock of about 38.2 million sqm of industrial property stock as at 2011. Are they able to dictate rental rates?’ asked an Ascendas Funds Management spokesperson rhetorically.

‘Recent media headlines of high percentage increase in rental rate in certain segments of the industrial property market is a result of catching-up to market rent level as a result of the change from public to private ownership,’ the spokesperson added.

According to a CapitaMall Trust Management Ltd spokesperson, rental reversions for malls in CMT’s portfolio averaged 2.1 per cent a year in the last two years.

‘In that same period, our tenants’ sales have increased even faster – by more than 6 per cent a year – showing that our tenants continue to do well in our malls,’ it added, crediting its strong track record in asset enhancement, which has helped increase shopper traffic and thus tenants’ sales.

Still, business owners look back to the time when JTC was a benevolent landlord. Allen Ang, group managing director of Aldon Technologies Services, pointed out that JTC initiated a rent reduction of 15 per cent during the 2009 financial crisis.

Rent now makes up about 11 per cent of the group’s overhead costs. ‘This is a substantial sum in an operation like ours. Considering our operations/business and industry norms, ideally the rents should stay at around 7 per cent to 8 per cent,’ Mr Ang said.

He has signed a third lease for a three-year term, from 2010 to 2013. The monthly rent for year one is $40,295, while monthly rent for year two is $43,498, a year-on-year increase of 8 per cent.

The SME Committee’s recommendation for JTC to review its role is an attempt to address these issues. A second recommendation calls for a one-off grant to help relocate SMEs with low value-added activities to lower-cost countries.

The recommendations, among others, will be presented to the Ministry of Finance and the Ministry of Trade and Industry ahead of Budget 2012.

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The way REITs and property in general is managed in Singapore is no different from dotcoms during the dotcom boom: everybody knows there is no way the situation is sustainable, but pretends it is a non-issue to make hay while the sun shines (or downright making a poultry factory out of goose that lays golden eggs) . The time will come when everything explodes but the REIT managers will have collected their bonuses and enjoying sunshine somewhere else.

It is socially not acceptable for a party like JTC to profit from a monopolistic control of resources.

Solution – create a separate monopolistic entity that has the trappings of a private entity with the effect of optimising the allocation of resources so as to achieve market equilibrium in pricing (aka profit maximisation aka squeeze u dry dry). Brilliant!!